Capital gains tax passed for QFII

China's financial regulators have drafted rules which will impose a 10 percent capital gains tax (CGT) on qualified foreign institutional investors (QFII) operating in the country, the China Business News reported Wednesday, citing an insider close to the matter.

No timetable was mentioned regarding when officials intend to start levying the tax, which experts say is aimed at regulating QFII activity in the wake of recent increases to their investment quotas.

Since 2003, when China's QFII scheme was introduced, regulators have long been divided on the subject of whether or not to tax the returns on the equity positions of overseas investors, Dong Dengxin, the director of the Financial Securities Institute at Wuhan University of Science and Technology, told the Global Times. For years, QFII yields were considered too small to bother taxing, so the subject of CGT was usually quickly shelved whenever it was brought up by the media or mentioned by officials, according to Dong.

However, the uncertainty surrounding whether regulators would eventually begin taxing QFII led many foreign capital holders to shy away from using these institutions to tap the Chinese market on their behalf, Zhang Haochuan, director of the research department from Z-Ben Advisors, a Shanghai-based fund investment consultancy, told the Global Times. With QFII returns already low owing to the volatility in the Chinese equity market, potential investors feared that taxes would squeeze profits even further, said Zhang.

But with financial authorities speeding up the approval pace on QFII licenses and quotas over the past year, the growing QFII market has promoted regulators to codify a set of taxation policies for these institutions to both pacify some of the concerns of overseas retail investors and put the breaks on foreign capital flows into the mainland equity market, Zhang went on to say.

There were 188 foreign institutional investors operating in China's capital market with combined quotas adding up to $30.82 billion as of the end of September, up from 116 institutions with quotas totaling $21.63 billion by the end of last year, according to recent data from the State Administration of Foreign Exchange.

The State Council, China's cabinet, increased the country's overall QFII quota cap from $30 billion to $80 billion in April, among a slew of other efforts to allow foreign investors greater access to the country's stock market.